Financial markets

Sovereign debt crisis

The Italian job

Jul 11th 2011, 12:46by Buttonwood

KICK the can down the road far enough and eventually you break your foot. All of the efforts of European politicians to date have been designed to prop up Greece, Ireland and Portugal so that Italy and Spain will not be dragged into the mess. And what have they achieved? No solution to the crisis in Greece while contagion has spread anyway, in part because the EU has been so indecisive.

David Owen of Jefferies details the bad news in its latest note. Italy's GDP is around 5% below its end-2008 level and has grown only 7% since the euro was adopted in 1999. This performance is significantly worse than the euro-zone average. It is hard to see how Italy can grow itself out of its 120% debt-to-GDP ratio. The economy has steadily become less competitive over the years; the prices of its manufactured exports have risen 50% since 1999.

Italy's problems have been around for a while, of course, but what has prevented a crisis until now has been that for some years, the country has managed to keep its fiscal position under control - often running a primary surplus (revenues exceed expenditure before interest payments).

Nevertheless with some €1.6 trillion of debt, Italy is dependent on investors confidence to keep its interest payments low. In 2011, it expects to pay €73 billion of interest, assuming a 4% rate. But at 6%, interest payments would absorb another €35 billion a year. The current yield on 10-year debt is 5.4% and rising. This is a vicious circle. The higher the refinancing rate, the greater the worries about unaffordability, which means an even higher rate. And Italy has to refinance €500 billion of debt by the end of 2013.

The French are reported to have an exposure (public and private) of some $472 billion to Italian debt so will be keen on a bailout. The European Financial Stability Fund would have to be enlarged to deal with it. But we may be going down a road we have travelled before; as Italians take money out of their bank accounts to send abroad and private sector investors sell Italian bonds, official bodies may step in. So Italians (like the Greeks) may end up owing money to the taxpayers of other nations, making the question of debt restructuring even more politically sensitive.

Meanwhile, there has been more data on an issue that has intrigued this blogger - why US life expectancy has not improved as fast as that of other countries, despite high health spending. Obesity, smoking and greater inequality are some of the main factors being blamed.